Landis Case Underscores Tax Risks Tied to Digital Goods Sales

Landis+Gyr Midwest, Inc. v. Wash. Dep’t of Revenue illustrates the uncertainty and magnitude of imposing sales tax on digital goods and services. The case, argued on appeal Jan. 31, also demonstrates that these types of issues can take years to uncover (through audits) and then to resolve (through litigation).

During that time, interest accrues, and risk remains for the taxpayer or taxing authority. The types of digital goods and services at issue in Landis have evolved exponentially, so the associated tax uncertainty has grown simultaneously. For these reasons, sellers and purchasers of digital goods and services should act to minimize associated tax risks.

In this case, Landis+Gyr provided data extraction and conversion services to Puget Sound Energy. Each PSE customer has a meter that collects energy demand and usage data on location. Because this data’s format is incompatible with PSE’s accounting and billing systems, PSE paid Landis+Gyr $2 million per month to extract and convert that data into a usable format.The company didn’t charge sales tax to PSE.

Following an audit over a six-year period, the Washington Department of Revenue said Landis+Gyr owed more than $16 million of sales, tax plus interest and penalties, claiming the services are taxable digital automated services. Landis+Gyr argues that its work for PSE is a nontaxable “data processing service.” A trial court agreed with the WDOR, and Landis+Gyr appealed the ruling.

The applicable Washington statute defines taxable digital automated services as “any service transferred electronically that uses one or more software applications.” It defines nontaxable data processing services to be “a primarily automated service provided to a business or other organization where the primary object of the service is the systematic performance of operations by the service provider on data supplied in whole or in part by the customer to extract the required information in an appropriate form or to convert the data to usable information.”

The Washington Superior Court agreed with WDOR’s argument that the primary object of the Landis+Gyr/PSE transaction is the resulting output of the service, which is a taxable digital automated service, not a nontaxable data processing service. Because most states have chosen to tax (or not) and define (or not) similar types of services, this case is likely the first of many disputes in this area.

For example, Texas taxes 80% of the charge for data processing and defines that as “a service performed with a computer using the customer’s data. Entering, storing, manipulating, or retrieving a customer’s data is taxable. But merely using the computer as a tool to help perform a professional service is not taxable.” It provides a list of 18 examples, including data conversion services and data storage services.

California doesn’t tax automatic data processing services, which it defines as “those [services] rendered in performing all or part of a series of data processing operations through an interacting assembly of procedures, processes, methods, personnel, and computers.” Other states, such as New York and Pennsylvania, neither tax nor define data processing services.

This diverse tax treatment creates risks for sellers and purchasers of any digital good or service because it varies by state. But more important, as Landis demonstrates, a legislature (or tax department through regulatory and sub-regulatory guidance) can’t keep pace with business. Therefore, applying old laws to new ways of doing business inevitably creates uncertainty. Landis teaches a couple of lessons.

The lengthy tax appeals process exacerbates risk for taxpayers and taxing authorities.

• Landis involves an audit covering 2010 through 2016 and, assuming an appeal, the Washington Supreme Court won’t issue a decision in this case before 2025.
• Once decided, the parties must apply Landis to an additional eight years of transactions (2017 through 2025), which may more than double the risk.
• As a regulated utility, PSE needs to determine whether the impact of the case on its ratepayers.
• Both parties risk losing the more than $16 million involved in this case plus and whatever amount is involved for 2017 through 2025.

The parties may have been able to avoid this protracted uncertainty.

• The language in the Landis+Gyr/PSE contracts and statements of work are pivotal and may have been viewed more carefully from a tax perspective when drafted.
• It’s unclear whether Landis+Gyr or PSE sought from the WDOR prior the audit period.
• Finally, there’s no indication whether the company, the utility, or other affected taxpayers sought any legislative or regulatory clarification or change.

Business moves faster than legislatures and tax departments. Sellers of any digital good or service, tax administrators, and the courts are forced to apply old laws to new ways of doing business, which necessarily leads to uncertainty. The risk flowing from this uncertainty is compounded because no two states tax—or don’t—all types of digital goods and services the same way.

All stakeholders would benefit from identifying the goals of subjecting various digital goods and services to tax, understanding how thoughtfully drafted legislation and other guidance would further those goals, and having an honest and transparent dialogue to mitigate risk—especially those that sell digital goods and services—to explain to other stakeholders how their businesses operate.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Mike Semes is of counsel at BakerHostetler and is a professor of practice at Villanova University Charles Widger School of Law in the graduate tax program.

We’d love to hear your smart, original take: Write for us.